The S&P ETF vs Index Fund: What’s The Difference and Which Is A Better Investment?

s&p etfLearning how to invest in the stock market can be a very intimidating and confusing task at first.  There are thousands of stocks to choose from in all parts of the world, plus there are technical terms you need to familiarize yourself with, such as dividends, market capitalization, earnings per share, and indexes.  To make things even more complicated, there are other investments such as bonds, mutual funds, and exchanged-traded funds (ETFs).  So now, what is a S&P ETF?  What’s the difference between an ETF and index fund?   If you don’t know the answer to those questions, don’t worry, we have you covered.

Before we answer those questions, it’s important that you know what a stock market index is.  It is basically a measurement of the composite value of a group of stocks.  They are chosen through a set a rules or hand-picked by committees. For example, if you wanted to invest in the Dow Jones Industrial Average Index (DIJA), you would purchase shares of the 30 stocks within the index, meaning you would own shares from all 30 companies.  Indices are very useful in determining the daily movements in the marketplace.  The S&P 500 is considered to be the most popular index on the market.

What Is the S&P 500

Short for the Standard and Poor 500, the S&P 500 is a stock market index that seeks to represent the entire stock market.  It does this by tracking the 500 most popular stocks on the New York Stock Exchange (NYSE).  Over 70& of all U.S. equity is tracked by the S&P 500, which in turn gives us a broad snapshot of how well the U.S. economy is doing.  Some of the major companies in the S&P 500 include Microsoft, AT&T, Apple, Exxon Mobil, and General Electric.

What is an Index Fund?

An index fund is a type of mutual fund that buys stocks and holds them in a portfolio that replicates the index.  The main benefit of these are their low fees, which is important for long-term investing.  Since these are considered mutual funds, they are not purchased the same way as a stock is.  Therefore, you do not need a brokerage account to buy one.

What Is an ETF?

Exchange traded funds (ETFs) are open-ended investment funds that are traded on a stock exchange.  They are still fairly new but are quickly gaining popularity, mostly because of their low-cost fees and better tax benefits.  ETFs are able to get away with such low fees because they are less actively managed than mutual funds.  The objective of an ETF is to generate a return that replicates a specific index, such as a stock or commodity index, and not try to outperform the underlying index.

ETFs are bought and sold like stocks.  There is a bid price from buyers and an asking price from sellers.  You cannot simply place an order for $20,000 if you want to buy an ETF.  Just like a stock, you have to specify the number of shares you want to buy.

ETF vs Index Fund

Since both ETFs and index funds are passively managed, they are very popular among investors for their low fees.  They are also considered low risk investments, because of their diversification in stocks in bonds in single fund.  Also, both are easy to manage and monitor since they being handled by experts.  However, there are a few key differences between the two that should be noted.

Since index funds are bought through mutual fund accounts and ETFs are purchased as stocks, shareholder transaction costs are usually a factor for ETFs while index funds generally have none.  On the other hand, the expense ratio of an ETF is usually lower than an index fund.

Another key difference between the two are that incoming dividends from index funds are automatically reinvested for you.  If you like to rebalance your investments frequently using cash, ETFs might be a better choice since your dividends are accumulated until it’s distributed at the end of the quarter.

If you do not have a lot of money to start investing, an ETF might be a better advantage for you.  Vanguard currently requires a $1,000 minimum for investing in a mutual fund, while you can buy an ETF from them for the cost of a single share.

Lastly, the taxation of these two differ from one another, favoring ETFs.  Index mutual funds need to sell securities, therefore triggering tax events.  ETFs eliminate the need to sell securities and are also to rid themselves of capital gains inherited.

S&P 500 ETF or Index Fund?

Which one should you choose?  The answer is, it depends.  Your first thought should be if you have enough money to even purchase  the S&P 500 index fund.  If the answer is no, your obvious choice will be the ETF.  You also want to determine if you will be actively or passively trading.  Keep in mind that with ETFs, the bid and asking price can fluctuate, even within a few minutes, because they are priced to the market all during the trading day.  And because of the transaction costs, management fees, and taxes, you will want to balance out the differences and see which one is more beneficial from a financial standpoint.  Do some research from different brokerage firms to determine the expense ratios and fees.

Other Stock Courses

Now that you have a better understanding of index funds and ETFs, you should also learn about other aspects of the stock market and trading.  Whether you are still learning how to trade stocks or you are an experienced trader looking for further direction, we have a range of courses for you to choose from.  We even have a course on penny stocks if that is something you might be interested in.  Knowledge is a powerful tool, and the more you know about investing can translate to more money for you.